Christopher M. Candon
Grant R. Gendron
Sheehan Phinney Bass & Green
Manchester, New Hampshire
23rd Annual Northeast Bankruptcy Conference July 14-17, 2016
Plan support agreements (“PSAs”), also referred to as “lockup” agreements or restructuring support agreements, have become increasingly common in Chapter 11 bankruptcies. Proponents of the agreements contend that they promote a consensual Chapter 11 process, carrying forward a concrete proposal that the key constituents will abide to in seeking plan confirmation. Proponents argue that PSAs reduce the overall cost of the Chapter 11 case and provide certainty to the parties moving forward. But with the more frequent use of PSAs, additional scrutiny of the practice has followed. Opponents of PSAs argue that there is no better example of an impermissible sub rosa plan. Ultimately, the challengers contend, the Chapter 11 plan process is circumvented by these hastily- conceived agreements with little input and limited notice to the creditor body.
These materials provide a basic primer on the contents and workings of plan support agreements (“PSAs”), discuss policy concerns with respect to their use in modern restructurings, and provide a brief summary of important recent case law regarding their proper use.
II. Plan Support Agreement Basics
A PSA is a contract entered into between a debtor and creditors wherein the parties agree to support a plan for confirmation in a chapter 11 proceeding. Kurt A. Mayr, Unlocking the Lockup: The Revival of Plan Support Agreements Under New §1125(g) of the Bankruptcy Code, 15 NORTON J. BANKR. L. & PRAC. 729, 730 (2006). PSAs allow the debtor and involved creditors to more precisely negotiate the contents of the eventual plan and to agree on its support, which can benefit the debtor and creditors in various ways and make the postpetition process considerably quicker and less expensive.
A PSA may be entered into prepetition or postpetition, with different statutes, rules, and standards applying in each scenario.
PSAs are often used as part of an attempt to negotiate and “lock up” a plan before the debtor even files for bankruptcy. If the debtor and important creditors negotiate a plan and hold votes in favor of the plan prepetition, the process is called a prepackaged plan of reorganization, also known as a “prepack.” See, e.g., Andrew M. Troop et al., CONCURRENT SESSION: The Mechanics of Prepacks: What Happens Pre-Petition, and How to Make it Stick Post-Petition, 071714 ABI-CLE 123, (2014). Otherwise, a prepetition PSA is usually an agreement for the signatories to support (or at least not oppose) the agreed upon plan when it comes to the plan confirmation stage. A prepetition PSA is a pre-bankruptcy contract that the parties typically will seek to have approved as an executory contract postpetition through Section 365 of the Bankruptcy Code. Isaac Sasson, Judicial Review of Plan Support Agreements: A Review and Analysis, 9 N.Y.U. J.L. & LIBERTY 850, 851-52 (2015).
Parties to a Chapter 11 bankruptcy may also negotiate and enter into PSAs postpetition. Under this approach, the debtor must seek the court’s approval to enter into such a PSA pursuant to Section 363 if the PSA is outside of the usual course of business and uses the estate’s property. Sasson, supra, at 852.
The central issue for postpetition PSAs is whether the PSA complies with Section 1125(b) of the Bankruptcy Code. Section 1125(b) prohibits postpetition solicitation in favor of a plan unless transmission of (1) the proposed plan (or plan summary) and (2) a court approved disclosure statement has already occurred. Because the Bankruptcy Code does not define “solicitation,” it is up to courts to determine what is permissible under Section 1125(b). As discussed in further detail in the case-law section below, the majority of courts now define “solicitation” narrowly to permit a wide range of negotiation in furtherance of successful Chapter 11 resolution. See, e.g., Troop et al., supra, at C.; Bruce R. Zirinsky et al., Recent Issues in Plan Confirmation: Post Petition Lock-Up Agreements in Chapter 11 Plans, 051613 ABI-CLE 307 (2013).
Although PSAs may differ significantly in terms of their specific contents, the following features are common: (1) details regarding the plan’s core components; (2) an agreement to support (or at least not block) the eventual plan; (3) various predicate conditions upon which the agreement is based (e.g., no material differences exist between the plan described in the PSA and the plan subject to confirmation vote; the drafting and court approval of the disclosure statement); (4) provisions allowing for signatories to escape the agreement if necessary (i.e., a “fiduciary out”); and (5) remedies for breach, including specific performance. See, e.g., 16-CM21 COLLIER ON BANKRUPTCY §21.14; Clement J. Farley et al., Validity of Post-Petition Restructuring Support Agreements in Bankruptcy, 241 N.Y.L.J. 71 (2013); Mayr, supra, at 730; Sasson, supra, at 856-858.
III. Policy Concerns For and Against Plan Support Agreements
Although PSAs can have significant benefits for certain debtors, some worry about their impact on the Chapter 11 process.
a. Arguments in Favor of PSAs
Plan support agreements, and prepacks in particular, can considerably shorten the Chapter 11 process, saving the debtor significant amounts of postpetition spending in the process. Sasson, supra, at 858; Stephen D. Zide et al, In This Issue: Building Blocks, Prepackaged Bankruptcy: Is it Right for your Company?, 34-10 ABIJ 30, 30-31, 69. The shorter administrative period also reduces the damage to the debtor in terms of reputation, employee confidence, and other business considerations. See Farley, supra; Troop, supra. In the same vein, by conducting negotiations prepetition, the debtor may save considerably on the various administrative costs inherent in a Chapter 11 proceeding.
A core additional benefit to the parties to a PSA is the increased certainty the parties can have in the process’s outcome. Sasson, supra, at 857. The debtor can wait to file its petition until the PSA negotiations are complete, or can better negotiate postpetition to ensure a speedy resolution. Negotiation between debtors and creditors is a key goal of the Chapter 11 process, and it is helped significantly by the powers presented by PSAs. Farley, supra; In re Indianapolis Downs, LLC, 486 B.R. 286, 297 (Bankr. D. Del. 2013) (“the filing of a Chapter 11 petition is an invitation to negotiate”). Because courts have been very willing to approve PSAs as a whole, debtors may have some confidence that their PSA will be approved absent bad faith behavior by the debtor or major creditors. Sasson, supra, at IV.
b. Arguments Against PSAs
PSAs arguably subvert significant portions of the Chapter 11 process, and in turn may harm the goal of creating a plan that is beneficial to all parties. While negotiations between significant interested parties is essential to a successful Chapter 11 case, PSAs limit or altogether remove the usual procedural safeguards built into the Chapter 11 process. See, e.g., Zide, supra, at 30-31. The agreements are called “lock ups” for a reason – they bind parties to courses of action before all of the information is known, creating a risk of missing out on a later deal that creates more value for the estate. See, e.g., Sasson, supra, at 872-874 (citations omitted); Id. at V.A. While the obvious losers are the creditors left out of unfavorable PSAs, PSAs may also harm debtors by causing their estate to be undervalued or by forcing them to sacrifice too much in the process of negotiating with creditors for their agreement to a PSA. Id. at V. The debtor may also be functionally giving away what would otherwise be an exclusivity period in which only the debtor could propose plans. Id. at V.C. These problems may be exacerbated by the negotiations taking place outside of the open Chapter 11 forum and judicial review. See id. at IV. Additionally, PSAs and prepacks are not effective for all debtor types, and could instead risk votes being designated instead under 11 U.S.C. §1126(e). See Zide, supra; Zirinsky, supra.
IV. The Case Law
In Innkeepers, the Bankruptcy Court of the Southern District of New York was faced with the debtors’ motion to assume a PSA that was executed in the days prior to the Chapter 11 filing. In re Innkeepers USA Trust, 442 B.R. 227 (Bankr. S.D.N.Y. 2010). The court declined to approve the prepetition PSA under either the business judgment review or the heightened scrutiny standard applied to insider transactions.
The court thoroughly rejected the PSA. First, the PSA was never a disinterested business transaction because the debtors’ parent company was always intended to receive equity as part of the deal. Id. at 231. Nor was the decision entered into in “due care” because they never “shopped” around the market with the deal and because the PSA prevented the debtors from negotiating meaningfully with other creditors. Id. at 231-233. Second, there was no significant benefit to rushing into the PSA, locking the debtor into a path so early on in the case, especially since the PSA did not resolve $1.2 billion of the outstanding debt. Id. at 233. The debtor did not act in good faith in deciding to enter into the PSA or provide transparency to the creditors. Id. Finally, the “fiduciary out” was seriously flawed, presenting a major issue to the PSA’s approval because of its limiting effect on the debtor’s ability to act pursuant to their fiduciary duties. Id. at 235.
In rejecting the PSA, the court provided a helpful series of data points and analysis for actions violative of the requirements for a successful PSA. The court did not announce a prohibition on PSAs, but commented that the one proposed by the debtors was ill-conceived. Tellingly, the court found that the case and arguments by the opponents were not made by “out-of-the-money” constituents intended to extract hold-up value from “in-the-money” players. Id. at 236. Instead, the PSA failed to satisfy the impartiality required in a complex case and left the debtors paralyzed and unable to conduct a fair plan process to maximize value for all of the estates and treat all creditors with greater neutrality. Id.
The recent Genco case demonstrates the economic and business benefits of a prepack plan. Zide, supra, at 69- 70 (citing In re Genco Shipping & Trading Limited, 513 B.R. 233 (Bankr. S.D.N.Y. 2014)). The debtor in Genco entered into a PSA with its financial creditors as part of a prepack reorganization. Id. at 70. The debtor began soliciting support for its prepack plan, filed its chapter 11 petition, and sought the court’s approval of the plan during a first day hearing. Id. The court overruled some creditors’ objections and approved the PSA. Id. “[D]espite the appointment of an equity committee and a contested confirmation hearing,” “Genco emerged from bankruptcy after only 79 days with approximately $1.2 billion less debt and largely unaffected trade creditors.” Id.
In evaluating the motion to assume the PSA, the court found that the debtors’ decision to assume the PSA clearly met the “business judgment” standard. In re Genco Shipping & Trading Limited, 509 B.R. 455, 463-64 (Bankr. S.D.N.Y. 2014). This conclusion was supported by evidence that the Chapter 11 proceeding was an appropriate vehicle for the debtors to restructure its business, and the mechanism chosen (i.e., the “prepack”) would help avoid a long, drawn out Chapter 11 process and the attendant costs. Id. The non-debtor parties to the PSA also made significant concessions in the Chapter 11 case and provided for a meaningful recovery for all stakeholders. Id. The PSA also provided a fiduciary out that gave the debtors the ability to receive, review and negotiate unsolicited proposals for any better alternative transaction. Id.
c. Indianapolis Downs
In Indianapolis Downs the Bankruptcy Court for the District of Delaware reviewed the appropriateness of a postpetition PSA and whether such agreement can survive the challenges posed by Section 1125(b)’s restriction on solicitation. In re Indianapolis Downs, LLC, 486 B.R. 286 (Bankr. D. Del. 2013). After two prior Delaware cases rejected PSAs under Section 1125(b) because of solicitation concerns, Indianapolis Downs signaled a potential change of direction for the court. Id. at 295 (citing In re Stations Holding Co., Inc., 2002 WL 31947022 (Bankr. D. Del. 2002); In re NII Holdings, Inc., 288 B.R. 356 (Bankr. D. Del. 2002)). In the case, the debtors and various creditors entered into a PSA after months of negotiating. Id. at 292. The PSA was filed with the court immediately after its execution, contemporaneously with a proposed disclosure statement and accompanying plan. Id. The court approved the disclosure statement and later issued a decision regarding confirmation of the plan. Included in its confirmation decision was the issue concerning the appropriateness of the PSA whether the PSA creditors’ votes should be designated/not counted pursuant to Sections 1125(g) and 1126(e) of the Bankruptcy Code.
Following the reasoning of the Third Circuit’s seminal decision in In re Century Glove, 860 F.2d 94 (3d Cir. 1988), the court adopted the majority position that solicitation under Section 1125(b) must be defined narrowly. Indianapolis Downs, 486 B.R. at 295 (quoting Century Glove, 860 F.2d at 101) (“solicitation must be read narrowly. A broad reading of §1125 can seriously inhibit free creditor negotiations.”). Congress intended debtors and creditors to negotiate with one another during the Chapter 11 process, and the narrow understanding of solicitation better fits that goal. Id. Additionally, designating the PSA’s parties’ votes would be inconsistent with the bankruptcy code for two reasons. First, creditor suffrage is a bedrock of chapter 11 and a vote of the overwhelming majority of the creditors should not be ignored or discounted absent bad faith or wrongful conduct. Id. Second, the purpose of Section 1125 and Chapter 11’s disclosure requirements are to ensure that acceptance is not solicited when the creditors and stockholders are too ill informed to act. Id. (citations omitted). Here, on the contrary, the parties were “sophisticated financial players” “represented by able and experienced professionals throughout [the] proceedings.” Id. at 296. The court so held even though the PSA contained a specific performance remedy.
Put simply, Indianapolis Grounds stands for the idea that “courts must be chary of construing those disclosure and solicitation provisions in a way that chills or hamstrings the negotiation process that is at the heart of Chapter 11.” Id. at 297 (citation omitted).1
d. Residential Capital
In another case addressing the postpetition assumption of a PSA, the Southern District of New York’s Residential Capital ruling demonstrates the importance of properly constructed termination events in a PSA. In re Residential Capital, LLC, 2013 WL 3286198 (Bankr. S.D.N.Y. June 27, 2013). At the outset, the court remarked that the PSA was the result of many months of negotiations and mediation sessions and found support by a substantial majority of the debtors’ major claimant constituencies. Id. at 20. As a result, the court distinguished the case from that of Innkeepers. Id. The court approved the PSA, after a finding that the postpetition PSA did not constitute a “solicitation” under Section1125 because of the “numerous termination events that allow a party to withdraw from this obligation under certain circumstances” and because “none of the Parties have agreed to vote in favor of the Plan unless and until the Court approves the disclosure statement and their votes have been properly solicited pursuant to section 1125.” Id.
e. In re Kellogg Square Partnership
Cited by the Delaware court in Indianapolis Downs, the Bankruptcy Court of the District of Minnesota reasoned similarly in In re Kellogg Square, another postpetition PSA case. In re Kellogg Square P’ship, 160 B.R. 336 (Bankr. D. Minn. 1993). Kellogg is an important postpetition approval case because it explains that for a solicitation analysis, “the act by which the Debtor solicited [the vote] must be deemed to have taken place after the Court approved the amended disclosure statement, and only when the Debtor’s plan and disclosure statement and ballot were actually presented.” Id. at 340.
1 According to Webster’s Dictionary, “chary” means “cautious or careful.”